Give or take Iraq, transport and the odd rebellion, things are looking up

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What a shambles. The euro was kicked ineptly into the long grass. Public services were collapsing. Policies in key areas were in disarray. The Cabinet reshuffle was a colossal embarrassment, an admission of failure. There was a sense of drift.

This is not a summary of the last few months, but a broadly accurate evocation of the political situation at the end of this government's first year in power. By July 1998, the euro was nowhere to be seen, despatched into outer darkness by Charlie Whelan on his mobile phone from the Red Lion pub in Whitehall. The new government was trying to reform public services while keeping to the Conservatives' spending plans. Not surprisingly, some schools and hospitals were on the verge of collapse. Blair's aspirations to think the unthinkable on welfare reform were in a mess, so much so that he sacked both the ministers involved at the Department of Social Security in a panicky reshuffle aimed more widely at sticking two fingers up at Gordon Brown.

How was all this viewed at the time? The situation was perceived as a remarkable political triumph for Blair and his new government. The decision on the euro delighted both camps. The Prime Minister's approach to the public services and welfare reform was hailed as radical, at least as daring as any initiative instigated by Margaret Thatcher. One left-of-centre columnist applied the adjective "radical" 13 times in an adulatory column on Blair, although he only pointed to the introduction of NHS Direct as an example to back up his zeal. Even the reshuffle was seen as a great personal triumph, Blair stamping his authority on his government. He went off on his holidays with a whopping opinion poll lead and media plaudits ringing in his ears.

There were many impressive policies implemented in Labour's first year, but matters were nowhere near as smooth as they appeared on the surface. One senior government figure said to me at the end of the first year: "It is a miracle this government has not imploded." Another senior civil servant, one who observed events at very close quarters, told me later: "No one should underestimate how daunting they found it in the first few years. They found the switch from opposition much more traumatic than people realise."

Now we are in the reverse situation. Apparently the Government is in complete disarray, when in reality the second term is not as bad as it seems. In some ways it is more impressive than the early years of the first term, when instinctively timid ministers were treading even more carefully than usual. Public spending is substantially greater now, and it is starting to make an impact, especially in some schools. More doctors are being trained and, over time, that will make a significant difference. Tax credits are more generous and carefully targeted. Schemes such as Sure Start, aimed at helping children - and their parents - from poor backgrounds, are getting rave reviews, not least from some of those who have benefited from them. Blair and Brown are working fairly well together. A couple of weeks ago, when some commentators were claiming that the relationship was worse than ever, the Prime Minister asked the Chancellor to run the next general election campaign.

In terms of policy, the potential cock-ups have been addressed just in time. In the first term there were mock policy launches, launches without firm policies. Now there are mock rebellions, revolts over non-policies. This week many Labour MPs will vote against foundation hospitals, but they will be rebelling against not very much at all. There is a view in some ministerial circles that the powers supposedly being devolved to foundation hospitals already exist as a result of previous Acts introduced in the early 1990s by the Conservatives. In other words, existing legislation more or less grants all hospitals the limited flexibility being offered to those granted foundation status. The most significant element of the new legislation is that a few hospitals will be able to change their names. Brown rightly blocked the absurdity of allowing them the scope to spend more or less what they liked, on the assumption that the Treasury would bail them out if they went bust.

The second term could be seen in a glowing light, and in some ways deserves to be. Even the retreat over foundation hospitals could be portrayed in a positive way: "Bold Blair blocks silly reform". It is better to propose a silly policy and drop it, rather than press ahead with it. Look at what happened to Thatcher when she showed her determination to impose the poll tax.

So why is there so much intense unease, not least within the Government itself, where senior figures describe the recent period as the worst since Labour came to power in 1997? Partly it is the war against Iraq. The failure to discover any weapons of mass destruction and the continuing instability in Iraq hover over this second term, a dark sky that does not move away.

In terms of the domestic agenda, I suspect the reason the Government does not get more credit is that transport continues to be a disaster. This is the public service that everyone depends on, much more so than on the NHS and schools, services that serve only limited sections of the population. It is a mystery to me why the state of transport is not considered a matter of urgency, although even here the record of the second term is more impressive than the first. At least ministers have dismantled the incompetent and hugely expensive Railtrack. Still, they could be doing a lot more. If the roads were clearer, the trains and Tubes better and cheaper, people would start to conclude that public services as a whole were improving.

Instead, voters are getting restless. Newspa- pers sharpen their knives. Parts of the BBC follow suit. The atmosphere changes. In the early years, ministers were mistaken when they viewed the second term as a land of milk and honey where a thousand radical policies would bloom more easily. What they did not realise was that during that first term they were skipping along, footloose and fancy free, and could have dared to do much more. Now they are doing more; but the terrain is thornier and more hazardous. In the first term there was a sense that Blair could walk on water. If he strode across the Thames today, there would be a widespread view that it was all a trick of the light arranged by Alastair Campbell. In reality, the first term was not as mesmerising as the long honeymoon suggested it was. The second term is better than some voters, and even some ministers, believe.